July 27, 2011
…It’s common knowledge that California is hurting for money. Why should internet-based merchants be exempt from the grasping, revenue-seeking hands of government? ….It’s perhaps not that simple. First, it’s not clear that these taxes are particularly good at raising revenue….
California recently followed in the footsteps of several other states (New York, Illinois, Rhode Island and North Carolina*) by passing a law requiring large out-of-state online retailers who receive referral sales from in-state residents to collect sales tax on sales to California residents.
Here’s the basic scenario:
Let’s say that we have an online marketing company residing outside of California, which we’ll call “Ama-zing” (clever, right?), and this fellow we’ll call “Joe,” who operates a retailing website in California. Through his website, Joe markets books that Ama-zing sells through its website. When a customer on Joe’s website clicks on a link on Joe’s website for a book listed on Ama-zing’s site, Joe’s website links the customer to Ama-zing’s website with a particular URL that tells Ama-zing’s website that the customer was “sent over” from Joe’s website. If the customer ends up buying that particular book Joe gets a percentage, perhaps fifteen percent, while if the customer buys a different book Joe gets a smaller cut of those profits. This is called pay-per-action (PPA) advertising, because, in contrast to “banner” ads (where the originating website receives commission for each user who clicks through the banner), Joe only gets paid by Ama-zing if the customer ultimately buys something
Ordinarily, a nonresident company cannot be compelled to collect sales and use tax in a particular state unless it has a physical presence, i.e., a bricks-and-mortar location, in the state. Quill Corp. v. North Dakota, 504 U.S. 298 (1992). Quill is generally interpreted as applying to e-commerce vendors, although courts have not foreclosed the question of whether out-of-state internet vendors are distinguishable from the mail order vendors in Quill. You can find a good article on state taxes on e-commerce on Westlaw at ECOMM WGL ¶ 14.03.
California’s law attempts to push the limits imposed in Quill by defining “retailer engaged in business in this state” to include “any retailer entering into an agreement or agreements under which a person or persons in this state, for a commission or other consideration, directly or indirectly refer potential purchasers of tangible personal property to the retailer, whether by an Internet-based link or an Internet Web site, or otherwise.” (The law is limited in scope to retailers who receive more than $10,000 from in-state affiliates and have more than $500,000 in yearly sales to in-state residents.)
So far, so good, right? It’s common knowledge that California is hurting for money. Why should internet-based merchants be exempt from the grasping, revenue-seeking hands of government?
It’s perhaps not that simple. First, it’s not clear that these taxes are particularly good at raising revenue. Rhode Island’s General Treasurer, Frank T. Caprio, says the tax on affiliates has “hurt Rhode Island businesses and stifled their growth, as they’ve been shut out of some of the world’s largest marketplaces” and called for repeal of the Rhode Island statute. And multimillionaire publisher Steve Forbes has sharply criticized the tax, calling California a “pickpocket state,” and arguing that damage to the state’s economy from the tax will far outweigh any revenue gains. Further, raising revenue may only be part of the story. Amazon complains that the impetus behind these taxes is driven by big-box retailers who are based outside the state but have a physical presence and are therefore already collecting sales tax.
It’s likely other states will follow suit, especially if California’s tax stands up to challenge in the courts. And other large internet retailers like Overstock.com and Drugstore.com are potentially affected by these laws as well. I’d be surprised if this issue went away anytime soon.
The California law is too recent to have made its way into caselaw, but a similar New York statute withstood constitutional challenge fairly recently. In 2010, a New York appeals court upheld the lower court’s ruling that a New York statutory provision similar to the recent California law did not on its face violate the Commerce Clause, but directed the lower court to reinstate for further discovery on whether the statute is unconstitutional as applied. Amazon.com, LLC v. New York State Dept. of Taxation and Finance, 81 A.D.3d 183, 913 N.Y.S.2d 129 (1st Dep’t 2010).
I found that case by running this query in NY-CS:
*If you’d like to see more on this issue, you might start with equivalent statutes in New York, NY TAX § 1101(b)(8); North Carolina, NC Gen Stat § 105-164.8(b)(3); and Rhode Island (RI Gen Laws § 44-18-15(a)(2).)